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FLIR Systems (NASDAQ:FLIR)

Q4 2012 Earnings Call

February 07, 2013 11:00 am ET

Executives

William W. Davis - Senior Vice President, Secretary and General Counsel

Earl R. Lewis - Chairman, Chief Executive Officer, President and Chairman of Strategy & Technology Committee

Andrew C. Teich - President of Commercial Systems

William A. Sundermeier - President of Government Systems Division

Anthony L. Trunzo - Chief Financial Officer and Senior Vice President of Finance

Analysts

Noah Poponak - Goldman Sachs Group Inc., Research Division

Jeremy W. Devaney - BB&T Capital Markets, Research Division

Michael F. Ciarmoli - KeyBanc Capital Markets Inc., Research Division

Peter J. Arment - Sterne Agee & Leach Inc., Research Division

James Ricchiuti - Needham & Company, LLC, Research Division

Jonathan Ho - William Blair & Company L.L.C., Research Division

Peter J. Skibitski - Drexel Hamilton, LLC, Research Division

Timothy J. Quillin - Stephens Inc., Research Division

Paul Coster - JP Morgan Chase & Co, Research Division

Brian W. Ruttenbur - CRT Capital Group LLC, Research Division

Operator

Greetings, and welcome to the FLIR Systems Fourth Quarter 2012 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce Mr. Wit Davis, Senior Vice President, General Counsel and Secretary for FLIR Systems.

Thank you. Mr. Davis, you may begin.

William W. Davis

Good morning, everyone. Before we begin this conference call, I need to remind you that other than statements as to historical fact, statements made on this conference call are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and are based on our current expectations. Words such as expects, anticipates, intends, believes, estimates, and variations of such words and similar expressions are intended to identify such forward-looking statements. All of these statements are subject to risks and uncertainties that could cause actual results to differ materially.

Please refer to the press release we issued earlier today for a description of factors that could cause actual results to differ materially from those forecast. The forward-looking statements we make today speak as of today, and we do not undertake any obligation to update any such statements to reflect events or circumstances occurring after today.

Let me now turn the call over to Earl Lewis, Chairman and CEO of FLIR Systems. Earl?

Earl R. Lewis

Thank you, Wit, and good morning, everyone, and welcome to FLIR's Fourth Quarter Earnings Call. In the fourth quarter, we earned $0.52 per share on revenues of $386 million. And for the year, we earned $1.45 per share.

2012 proved to be a demanding year for many of our businesses. However, we used this difficult environment to improve our business. We focused on building a strong backlog of orders from a global base of customers, shifting selling efforts from Europe to the Far East and reducing our tax rates and our overhead cost in a meaningful way. We have rationalized our operating centers, improved our gross margins and introduced strategic pricing and many efficiency improvements in our businesses.

In addition, we have lowered our equity capital and acquired 2 accretive, highly strategic businesses. These changes will create operating leverage that positions us for a more FLIR-like performance in 2013.

Some of these actions helped us in the fourth quarter, where we reduced our SG&A spending by 11% compared to last year. Our Commercial Systems division had its highest operating margin in nearly 10 years, and our Government Systems business increased its margin sequentially for the third quarter in a row.

Our business continues to generate significant amounts of cash, with Q4 operating cash flow approximately 150% of our net income and nearly 130% for the year. We used this cash to invest in our long-term future as a company, as well as return capital to our shareholders through the repurchase of 4.5 million of our shares during the fourth quarter, which brings our total repurchase for the year to 10.5 million.

Additionally, we closed on the acquisitions of Lorex and Traficon during the last 2 weeks of 2012. We are excited about both businesses, Lorex with their consumer retail Internet and professional distribution and high-volume product development capabilities; and Traficon for their strong presence in traffic monitoring systems and image analytics. We expect these acquisitions to both be accretive in 2013.

We believe that 2013 will be strong from a cost and profitability perspective, and we're very optimistic we will see a return to top line growth as we introduce new products and continue to increase the value-to-price ratio of our technologies. While our commercial markets have been impacted by some of the macroeconomic factors that are illustrated by housing starts, unemployment and industrial production, we see signs that stabilization has begun and are hopeful for a modest recovery.

Government Systems backlog is stronger than it was a year ago, and we continue to see good opportunity pipelines for our products, especially in the advanced security applications around the world.

Today, we announced our outlook for 2013. We are expecting revenue between $1.5 billion and $1.6 billion for the full year and earnings per diluted share in the range of $1.56 to $1.66.

I'm going to now turn the call over to Andy Teich, who's going to discuss the performance of the Commercial Systems division. Andy?

Andrew C. Teich

Thanks, Earl. The Commercial Systems division finished the fourth quarter with a 5% decline in revenue compared to the prior year. Division operating margin increased over 1 percentage point year-over-year to reach a record high of 30%. This is a result of focused efforts to maintain gross margins and control overhead cost.

Regionally, the Asia region grew 5% when compared to the fourth quarter of last year. However, our Americas and EMEA regions declined 3% and 13%, respectively.

Revenue in the TVM and Raymarine segments declined 5% and 7%, respectively, versus the fourth quarter of 2011. These declines were driven primarily by weaknesses in the EMEA region. Both segments increased their operating margins both sequentially and versus the prior year as we controlled overhead and selling expenses.

Overall, Commercial Systems division bookings dollars for the quarter were up just over 1% compared to the fourth quarter of 2011. The Americas and APAC regions grew their fourth quarter bookings dollars 7% and 12%, respectively. But that growth was offset by the EMEA region, which declined 11%.

Full year 2012 bookings for the division were down 3% versus 2011, again, with EMEA driving the decline.

Fourth quarter bookings dollars in the TVM segment increased 2% over prior year. TVM's Thermography line of business saw bookings dollars grow 6% in the fourth quarter, the first year-over-year growth in the Thermography business since the third quarter of 2011. Also, the fourth quarter represented the highest-ever bookings dollars quarter for the Thermography business. The primary driver of the Thermography bookings growth in the quarter was strong demand for our premium line of cameras, largely driven by demand for our new T-Series of products.

TVM's Cores & Components bookings dollars grew 13% compared to the fourth quarter of 2011. Strong growth in uncooled cores, including our Quark core, was partially offset by weakness in our higher-priced cool cores. All 3 of the cores' geographic regions posted double-digit bookings growth over the fourth quarter of last year, with Asia Pacific growing nearly 30%.

Bookings dollars in TVM's security line of business declined significantly compared to the fourth quarter of 2011. Approximately $8 million of this decline was attributable to activity in Q4 of 2011 for oil platform security and border programs that did not reoccur in 2012.

That said, the total number of units booked in the security line of business grew 30% and hit an all-time high. This demonstrates the evolving nature of our security business, where a growing percentage of our sales will be coming from uncooled cameras and the business becomes less dependent on higher-end security projects for things such as border security, all while maintaining our gross margins.

The addition of Lorex will be another step in this direction as we are actively investing to significantly reduce the cost, and thus enable, wide adoption of thermal imaging. Lorex's do-it-yourself camera systems, along with their integrator quality systems, will provide an avenue to integrate these increasingly affordable thermal technologies into a very large number of sockets.

As Earl mentioned, the addition of Traficon represents another important strategic step for FLIR. Prior to the acquisition, we had a small but rapidly growing traffic business within our security line of business. Given the considerable opportunity we see in furthering thermal into roadway monitoring markets, we intend to create a new line of business called FLIR ITS, or Intelligent Traffic Systems, that will be focused on this effort.

Both of these acquisitions ultimately support our strategy of creating a fully-automated thermal and visual security camera product family that can be used in a wide variety of consumer and industrial applications.

To that end, our low-cost, high-volume, next-generation camera core development has been progressing well. This development should enable an order of magnitude in cost reduction and a similar order of magnitude increasing unit volumes. This development, which has been ongoing for 2 years now, will allow us to begin shipping a new class of products in early 2014. We expect this development to allow us to both leverage the price elasticity in our existing markets and to explore several new applications where high-resolution imaging is not necessarily needed. These applications include low-end security, Personal Vision Systems, building control, automation and transportation systems.

TVM's Maritime business saw a 30% decline in bookings during the quarter. This dropoff was primarily due to a tough comparison to Q4 last year, where we booked an unusual number of our high-end Voyager systems. Stripping out this effect, the Maritime business bookings dollars grew in the high-single digits.

The Personal Vision Systems line grew year-over-year bookings dollars over 40% and bookings units over 60% during the quarter. All regions contributed to this growth, but the products sold particularly well internationally. For the full year of 2012, PVS was our fastest-growing line of business, and we're very enthusiastic about new products that are under development to further penetrate the first responder, outdoor enthusiast and other consumer markets.

Raymarine bookings dollars declined 1% versus the fourth quarter of 2011. Bookings to OEM boat builders again declined, as the demand for new boats continues to be soft, but this channel was offset by stronger demand for Maritime electronics wholesalers. Raymarine's EMEA regions bookings declined 9% in the quarter, which was partially offset by 5% growth in the Americas and double-digit growth in Asia Pacific.

The introduction of the a65, a67 and e165 helped drive multifunction displays bookings growth during the fourth quarter, and we are looking forward to shipping our Draganfly MFD for the freshwater market to bolster our product offering and reach a broader spectrum of boaters.

That concludes my summary of the Commercial Systems business, and I'd like to now pass the call over to Bill Sundermeier, who will discuss the results of our Government Systems division. Bill?

William A. Sundermeier

Thanks, Andy. During the year, we made a series of difficult decisions to rightsize our operations and reduce costs. These actions helped offset lower revenue during 2012, but also positioned Government Systems for operating leverage in the future. As procurement sluggishness continues, we're watching the U.S. Defense budget situation closely and are hopeful for better resolution to clear up the uncertainty that overhangs our business. In the meantime, we have conservatively aligned our business to reflect a cautious view towards the U.S. budget situation for 2013.

In Q4, divisional revenue declined 4% versus the prior year, which represents our best performance since the fourth quarter of 2010 when you exclude the newly acquired ICx revenue in that quarter. As expected, bookings were below revenue, given the seasonally slow fourth quarter, but were higher than the fourth quarter of 2011 by 9%. For the full year, bookings in the division were up 8% over 2011.

Backlog ended 2012 at $356 million, which represents a 13% increase over last year.

Operating margin for the Government Systems division continue to improve sequentially, reaching over 28% in the quarter, highlighted by a record operating margin in the Integrated Systems segment and stable sequential margins in the Surveillance segment.

The Surveillance segment finished the quarter with backlog of $261 million. Surveillance book-to-bill of 0.8 was the highest fourth quarter ratio since 2008. Our international markets contributed 55% of Surveillance segment bookings in the fourth quarter, as our initiatives to build out our worldwide sales staff bear fruit.

The largest order in the Surveillance segment during the quarter was for over $17 million to outfit the fixed-wing aircraft of the Afghan Air Force with several of our Star SAFIRE III gimbals. We also won a $12 million contract to support the Brazil police force's security initiatives for the upcoming World Cup and Olympic Games. We were awarded a $4 million award to outfit Canada's Special Operations Command with technical thermal scopes. A $3 million award for our Star SAFIRE HD systems for the Turkish Land Forces shows our growing presence in Turkey, which historically has been a sole source market for another company.

These orders are an example of how our customer and countries list continues to expand as a result of our diversifying sales organization and a growing set of high-quality, high-value products. This has been a key element of our strategy, and we will continue to invest our own dollars to innovate cutting-edge products and to build out our global reach.

While the presidential election and sequestration dialogue impacted the pace and timing of RFPs, schedules and orders from Surveillance's U.S. customers, we were able to book awards that illustrated how ISR products remained a mission-critical, force-multiplying solution. For example, we won a $10 million contract from the Marine Corps for our Recon man-portable imaging units. We also booked a $5 million with the U.S. Navy for gimbal systems for use by the Navy's specific fleet. Additionally, the Army MEDEVAC program again showed to be a key customer of our long-range thermal imaging technology, with an order worth over $3 million.

The Detection segment ended the year with $24 million in backlog and finished 2012 a different business than it was when the year had begun. During the year, we consolidated Detection's operating footprint from 7 locations to 3 and added new management to advance CBRNE technologies to improve productivity and expand worldwide distribution.

We also drove down the amount of low-margin contract R&D in the Detection segment by $17 million during the year, which was the reason segment revenues were down, but is consistent with our strategy to focus our sales and engineering workforce on products rather than cost-plus R&D.

Bookings activity during the quarter included over $2 million in orders for our IBAC air monitors from several customers in the U.S., India, China, Russia and Germany. We received several orders for our Fido explosive detectors, a large percentage of which were from the U.S. Army under our program of record. Detection's radiation products continue to sell into many international markets, and the technology is involving and opening up some new, interesting applications.

Our goal for the Detection segment for 2013 is to improve profitability by leveraging an improved cost structure, expanding international distribution, further decreasing the amount of contract R&D in the business and introducing new, higher-margin products.

The Integrated Systems segment had its best quarter from a revenue and profitability standpoint since we acquired the business as part of our 2010 ICx acquisition. Revenues more than doubled compared to Q4 of 2011 and operating margin reached 16%.

Integrated Systems finished the year with a backlog of $71 million. Significant orders during the fourth quarter included a $7 million booking from the Qatar Ministry of Defense for 3 of our new MVSS trucks, which is the international version of our MSC surveillance system.

Integrated Systems also booked an airport security project with the City of Vancouver airport that continues our momentum in the advanced security systems for integral entry points around the globe.

On the software side, the segment continues to prove its command and control system capabilities, with the nearly doubling of its orders over the prior year, including a project for the Los Angeles Metro Transit Authority.

During the quarter, we also began shipping our DRC chemical warfare detection units under the $27 million order received from the U.S. Army in Q3.

That concludes my comments on third quarter. Tony Trunzo will now review the fourth quarter and full year 2012 financial results in more detail.

Anthony L. Trunzo

Happy to do that. Thanks, Bill. Third quarter consolidated revenue was $386.4 million, 5% lower than the fourth quarter of 2011. International revenue is 53% of the Q4 total, compared with 49% in the fourth quarter of 2011, and was 49% for the year, the highest proportion in more than 10 years. Sales to the U.S. Government represented 28% of total revenue in Q4, compared to 24% of total revenue in the fourth quarter of last year. The Lorex and Traficon acquisitions, which closed on December 20 and December 28, respectively, did not contribute any revenue in Q4.

Consolidated Q4 gross margin was 51 -- 53.1%, compared to 55.5% in the fourth quarter last year, and consolidated operating margin of 25.9% was 1.2 percentage points lower than Q4 of 2011. Lower gross and operating margins were attributable to the Surveillance segment, which posted Q4 income of $45.3 million and segment operating margins of 33.2%, 7 percentage points lower than Q4 of last year. Less favorable product mix comprised almost all of the decline, as operating expenses were down from last year.

TVM segment operating income of $61.6 million was down 2.5% from last year, but segment operating margin improved 80 basis points to a record 34.2%, due to a 9% reduction in operating costs.

Raymarine earned $1.2 million in operating income for the quarter, compared to breakeven last year, due to an 18% reduction in operating expenses.

Integrated Systems segment operating income was $3.9 million, up more than 150% compared to last Q4, due to much higher revenue, partly offset by lower gross margins.

The Detection segment reported $300,000 in operating income, a $1 million improvement from last Q4's operating loss of $700,000.

Overall, selling, general and administrative expenses declined by 11% compared with Q4 of last year. Earnings before interest, taxes, depreciation and amortization and stock-based compensation in the quarter were $121 million, down 8% from the prior year.

For the full year 2012, consolidated revenue declined by 9% to $1.4 billion. TVM segment revenue declined by 5% to $628 million and represented 44.7% of total revenue for the year. Raymarine revenue was $158.2 million compared with $171.5 million in 2011. Surveillance segment revenue of $486.4 million represented a decline of 16% for the year. Detection contributed $63.3 million in revenue, down 21% from last year, due to much lower contract R&D revenue. Integrated Systems reported a 27% increase in revenue to $69.5 million. International revenue represented a record 48.9% of the 2012 total, continuing a 4-year upward trend, while sales to the U.S. Government represented 26.6% of the annual total, the lowest percentage since 2003.

Full year gross margin was 52% compared to 53.7% last year, largely due to fixed-cost absorption and mix changes in Surveillance.

TVM reported 2012 operating income of $171.3 million, down from $194.7 million, and Raymarine segment operating income declined by 6% to $11.2 million for the year. Surveillance segment operating income was $160.2 million compared with $208.5 million in 2011. Detection posted operating income of $1.1 million compared to a loss of $5.6 million in 2011, while Integrated Systems operating income tripled to $5.2 million. 2012 EBITDA plus stock comp was $387 million or 27.5% of revenue.

Full year selling, general and administrative expenses were 21% below 2011, reflecting substantial cost reductions across all operating segments. We expect to continue our focus on reducing costs and improving efficiency in 2013 and beyond.

Our tax expense in Q4 was $19.5 million or 25 -- excuse me, 20% of pretax quarterly income. And for the full year, our tax rate came in at 22.8%. The fourth quarter tax expense reflected downward adjustments to the full year based on reconciliation of estimated tax expense booked in the first 3 quarters of the year. Going forward, we expect our tax rate to be approximately 25%.

Cash provided by operations for the fourth quarter was $112.9 million, equal to 146% of net income. For the full year, cash provided by operations was $285.5 million and 128% of net income, both records for FLIR.

During Q4, share repurchases totaled $85.2 million, capital expenditures were $18.9 million, and we invested $105.9 million in 2 strategic acquisitions.

Our year-end cash balance of $321.7 million leaves us with ample flexibility to continue to invest in our business, return meaningful capital to shareholders and make strategic acquisitions, all while maintaining our investment-grade credit rating.

During Q4, we purchased 4.5 million shares of our stock at an average price of $18.84 per share, including a 3 million share block transacted privately at $18.55. For all of 2012, we repurchased 10.5 million shares of our stock at an average price of $20.47 per share.

Yesterday, our board approved a new authorization for the purchase of up to 25 million shares over the next 2 years. We expect to utilize a portion of this authorization during 2013. But as always, the actual amount of any repurchases are dependent on the prevailing share price. Of note, since inception in 2003, we have repurchased 47 million shares of our common stock at an average price of $16.44, representing a program to-date internal rate of return of 26%.

As Earl stated earlier, we announced our revenue and earnings per share outlook for 2013 today. We currently expect revenue for the year to be in the range of $1.5 billion to $1.6 billion, reflecting an increase of between 7% and 14%, and earnings per fully diluted share to be in the range of $1.56 to $1.66, representing an increase of 8% to 14%.

This outlook assumes some modest recovery in the global economic outlook, as well as approximately $100 million in revenue from Lorex and Traficon. We see continued risk in our government markets, but are encouraged by the growth trends in both bookings and backlog.

Finally, we announced a 29% increase in our quarterly dividend to $0.09 per share, reflecting our continued confidence in FLIR's future. It's actually $0.09 per share per quarter. This increase represents a modest payout ratio of approximately 20% and keeping with our view of the dividend as one component of a larger strategy whereby we position the payout ratio at a level that provides ample funds for strategic growth and share repurchase.

The first quarter dividend will be paid on March 8 to holders of record as of February 19.

This concludes the summary of our fourth quarter and annual financial results. I'll now turn the call back over to Earl.

Earl R. Lewis

Thank you, Tony. In the fourth quarter, both our divisions grew their bookings compared to the prior year, with Government Systems leading the way with 9% growth. Total company backlog is $64 million higher than it was at the end of 2011. This was in the face of global -- governmental budget cloudiness and significant economic uncertainty. We operate our businesses by managing those things that we can control, things like productivity, pricing, overhead costs, facilities and the like. I commend our people for doing just that, and in turn, establishing a business that is very well positioned for continued competitive financial success. We welcome the employees of Lorex and Traficon to FLIR, and we look forward to 2013.

And with that, operator, we'd like to take questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Noah Poponak of Goldman Sachs.

Noah Poponak - Goldman Sachs Group Inc., Research Division

So can you tell us what's in the 2013 guidance for continued share repurchase going forward?

Earl R. Lewis

Yes. We won't tell you the exact number, but we have some in our budget, planned purchases. We, of course, haven't established the budget based on a lot of purchases because we don't know what the price will be, but we did put some in.

Noah Poponak - Goldman Sachs Group Inc., Research Division

So it's not just the new authorization divided by 2, given that it's 2 years. It's not that?

Earl R. Lewis

No, no. We wouldn't do that, no.

Noah Poponak - Goldman Sachs Group Inc., Research Division

Okay. And then, appreciate the comment that the guidance assumes a modest improvement in the macro and continued risk in government. I don't know if you'll get as scientific as telling us the specific organic rates for each segment that's in the 2013 guidance, but maybe if you could just give a little bit more color on what we should be looking for there?

Earl R. Lewis

Well, in our internal thinking relative to growth, it's not a big number in either segment. We're not planning on a lot of growth in either one, frankly. But that's for budgeting purposes, that's to put together our cost, to put together our plans. I think we're relatively conservative in our estimate of the growth. I mean, you can do the numbers as well as I can, Noah. We've got $100 million coming out of acquisitions, and what we did this year, and you can interpolate, and you're less than 10%, that's for sure, on existing businesses.

Operator

Our next question is from Jeremy Devaney of BB&T Capital Markets.

Jeremy W. Devaney - BB&T Capital Markets, Research Division

Looking at the margin, segment profitability jumped around quite a bit over the last couple of quarters. This quarter, we saw segments all profitable for the first time sequentially. Can you take us through where you see Detection, Integrated Systems and Raymarine operating margin going forward?

Earl R. Lewis

Well, in our thinking, they will improve slightly next year -- this year. Not giant, but they will all improve slightly. We entered 2013 with a very good, I think, cost background. So we anticipate, with not a lot of growth on the top line, some improvement.

Anthony L. Trunzo

And Jeremy, the -- it's Tony. The one segment that's probably going to be most challenged in terms of improving the margin percentage is Integrated Systems, because we've got some margin challenges in a couple of the programs there. Having said that, margin dollars should grow meaningfully because we see pretty good revenue growth in that segment, given the backlog it has.

Earl R. Lewis

What Tony is referring to is we had, actually, an inherited part of our backlog when we bought ICx, that we had at a relatively low margin. We'll have to ship that during the year. That's the one exception to the -- my comment I made.

Jeremy W. Devaney - BB&T Capital Markets, Research Division

That's the R&D work that they used to do, I'm assuming. Moving on, though, and looking at the U.S. Government business, in particular. You guys continue hitting singles and some doubles in there, but there don't really seem to be any needle-moving programs that are driving the business.

Are there any re-competes in FY '13? Or are there any programs in excess of $10 million scheduled to end in '13 and are there any programs that you're currently tracking in excess of $50 million? And then also, what does your guidance incorporate in terms of any DoD CR and/or sequestration taking effect?

Earl R. Lewis

Bill, why don't you tackle that? I just have a general comment. In terms of large programs, J2 is a very large program, and we don't know exactly whether it will get funded this year. The MSC program is well over $100 million, of which we know we have roughly $30 million so far. I'm very hopeful that whatever comes out of Washington, although we haven't built it into these numbers, will involve additional border security, where we have, as I mentioned a $110 million current IDIQ, $30 million that we ship in the first half. Bill, you want to comment on additional big programs?

William A. Sundermeier

Sure. We're currently tracking opportunities that are greater than $10 million and fewer in the greater than $50 million category. So there are still some large programs out there. Earl is talking about programs that we have in hand with large IDIQs like MSC. But there are some new programs out there that we're tracking which are definitely greater than $10 million in size and multiple. But we've really looked at this year very hard and been very conservative, assuming that we're probably going to be under a continuing resolution for this year. It's going to make procurement sluggishness continue, and we'll see what happens with sequestration. But we've tried to build a large amount of conservatism into our model, given that we're going to have a lot of headwind this year as well.

Earl R. Lewis

I don't think there's anything in our planning this year that's a $50 million contract.

William A. Sundermeier

Not that we expect to happen, to make this [indiscernible].

Operator

Our next question is from Michael Ciarmoli of KeyBanc Capital Markets.

Michael F. Ciarmoli - KeyBanc Capital Markets Inc., Research Division

Maybe just to stay on that topic of the contracting environment. What's the level of IDIQ contract exposure you have? I kind of ask that in the context of, if sequestration happens or the budget really gets tight, it seems like those contracts are going to be more vulnerable because there's no termination fees associated with them. So you assigned -- if you could maybe just us walk through your probability of assessing execution on those contracts in this environment?

Earl R. Lewis

Just a general comment, I'll let Bill talk. But none of -- no IDIQ contracts in our backlog. The only thing in our backlog would be, where we have truly an order that isn't cancelable, I'll put it that way. So the question is what additional funding might we get against some of those orders. I don't think we've factored a lot of that into our planning for this year. We factored some, for sure, but not a lot. Bill, you want to comment?

William A. Sundermeier

Sure. The -- when it comes to IDIQ, you said tracking total size of that, we don't -- and we told you -- don't have that here, we can get that for you. But in this case, as Earl said, we don't count that IDIQ quantity, and there are very few that we're anticipating on add-ons in the IDIQ space. What's fascinating is a lot of our IDIQs are in the area of security and Department of Homeland Defense as compared to pure military, which, I think, has a much more capable way of surviving through this as compared to a military IDIQ.

Earl R. Lewis

I mean, just in general, our philosophy on this is that buying ICx, et cetera, was to get into more the security side of chem, bio, for example. And I think that -- my thinking, anyway, is that, that has a higher probability of continuing to be purchased as it's essentially antiterrorist-type equipment as opposed to some offensive military equipment.

Michael F. Ciarmoli - KeyBanc Capital Markets Inc., Research Division

No, that make sense. That make sense. And then maybe one quick one for Tony. What -- I may have missed this. What's the expected free cash flow conversion for '13?

Anthony L. Trunzo

We should see cash flow from operations be somewhere in the same zone, I would think, that it is this year. We don't typically guide to that. This year, we converted cash flow from operations compared to net income at a 128% rate. That's been as good as it's been for FLIR. I think we'd like to see it be up in that same range again in 2013.

Operator

The next question is from Peter Arment of Sterne Agee.

Peter J. Arment - Sterne Agee & Leach Inc., Research Division

Just maybe a question for Bill, I guess. Everyone is focused on your overall kind of government exposure, which -- could you remind us, I think the last quarter was down to something like 29% to direct DoD. But what I'm more interested in is most of the cuts seem to be targeting the Army. So how do you split your mix with the company?

William A. Sundermeier

Actually, the DoD piece in Q4 was 20% of total revenue.

Earl R. Lewis

We failed miserably to penetrate the Army.

William A. Sundermeier

We have really focused in the last year or so to get broad, and we have a very strong order book this year internationally. So we've heavily factored our U.S. DoD business and expect lumpiness in that space. And so we've been really pushing more into federal DHS in the U.S. as well as international markets. So the way we're going to stay on top of this is to bring things abroad and cover any gaps that we might have in the U.S. DoD space.

Operator

The next question is from Jim Ricchiuti of Needham & Company.

James Ricchiuti - Needham & Company, LLC, Research Division

Just a question on Lorex and Traficon. If we look at these markets, when do you see thermal technology really being adopted in a larger -- on a larger scale in these markets?

Andrew C. Teich

Jim, it's Andy. So on Traficon, it's pretty much right away. We're selling -- we developed last year a camera specific to the traffic market and they're being deployed. You'll see many of them in the state of California, where we all are today. And those are being integrated today, together with Traficon, what they call VIP, their video image processing platform. Down the road, in the fall of 2013, you'll see a product get released that will be an integrated thermal plus Traficon back-end video analytics processing system, all-in-one package, which is the way the Europeans tend to like to buy the product. In the U.S., it's typically split cameras and back end processes are separate. Relative to Lorex, that's going to be a longer-term effort, and you will first see thermal deploy under the -- what is now known as the Digimerge brand, which is Lorex's integrator class or professional-grade, install product. Those will come out under the FLIR brand and that will be in Q3 of 2013. You probably won't see a Lorex branded product with thermal in it until likely the second half of 2014, when the low-cost sensor development that I spoke about in the prepared comments becomes available.

Earl R. Lewis

Andy, just a quick second, explain why it's better for traffic.

Andrew C. Teich

Yes, it's really a -- it's a very compelling value proposition there. Today, in traffic, the common solution is to use visible cameras. And visible cameras have issues with sun glint, sunrise, sunset, fog, haze, shadows, headlights. Those are all issues. And the other thing that's becoming quite prevalent and will be a vector that we'll pursue are bicycle detection and pedestrian detection. And California has got a particular initiative going on in that area right now. All of those things are much easier to do with thermal because you don't deal with color, you don't deal with effects of sun glint, sunrise, sunset, obscurants, all of those things go away. You've got a black and white image that's very easy to do analytics on. So I think the group of engineers that we've gotten [indiscernible] right now with the Traficon team are very much looking to develop, looking forward to refine those algorithms for thermal cameras.

James Ricchiuti - Needham & Company, LLC, Research Division

And my impression was video-based detectors, it really is -- the penetration has been relatively low for traffic management. It's still -- the ITS market, I think, is still relatively small. I mean, do you have -- would you be willing to give us a sense of how big a market opportunity you think this might be, looking out 3 to 5 years?

Andrew C. Teich

Yes. I don't have specific numbers, but I can tell you what you see when you travel around the world. The use of video at intersections is much more prevalent on the West Coast than it is anywhere else in the U.S. as an example. But if you look at where I come from, Portland, Oregon, or you look in California here, they're quite prevalent. And everything new that's being done is being done with video detection, because it just makes a lot of sense instead of cutting up roads and putting loops in, which are not terribly reliable technologies. And of course, there's also a green element relative to those, because getting vehicles to move in a more fluid and efficient way through intersections reduces idling time at stoplights and so forth, so there is a good angle there on that. The good news here and what you really alluded to is that the penetration rate is still quite low. So the total opportunity, I think, is significant as intersections are developed or upgraded around the world. And that's just one piece of Traficon's business. They also have a segment they call AID, which is automated incident detection, which is highway monitoring for a number of different things, looking for accidents, looking for debris in the road, looking for wrong way travelers on the road. And again, that's much more prevalent in Europe right now, but will become much more broadly used in the U.S. And then you add to that things like imaging in tunnels, which is quite prevalent. And then you've got crosswalk control, which is also another area.

Earl R. Lewis

One other I kind of like is monitoring for animals, which is a big cause of deaths. And in fact, it's the #1 cause in some of the Scandinavian countries, where you can actually align a number of infrared cameras along the side of the road and tell if there's an animal ahead of you. All of these things are, as you point out, future businesses that are pretty good, we think.

Operator

Our next question is from Jonathan Ho of William Blair.

Jonathan Ho - William Blair & Company L.L.C., Research Division

Just in terms of the $100 million in revenue from acquisitions, could you give us a rough sense of how to think about operating margins for 2013 related to these businesses?

Anthony L. Trunzo

Sure, Jonathan. It's Tony. The -- I think the Lorex numbers were publicly available. That's a fairly low-margin business. They're going to contribute to preponderance to the revenue. They're going to be a fairly low-margin business. Traficon is a software and middleware business and has meaningfully higher margins. It's a 20% of the total -- actually less than 20% of the total of the 2. The 2 acquisitions, for the year, we expect to add a few pennies per share to earnings. So they will, even after taking account of the amortization of the acquisition intangibles, they'll be accretive to earnings this year, but the operating margin is going to be meaningfully less than what you see from the rest of the business. As we move forward, and Andy was just talking about getting thermal technology into Lorex, that should help to lift those margins over time because it will be a significant differentiator in the market. But you're not going to see a lot of that in 2013. It still going to be a pretty low-margin business.

Jonathan Ho - William Blair & Company L.L.C., Research Division

Got it. And just along the lines of that question. Roughly, what percentage of revenue now will come from non-infrared and non-CBRNE businesses? Just as you guys have added, in terms of distribution capability, just wanted to get a sense from you guys in terms of what portion of the businesses are sort of these non-core products at this point?

Anthony L. Trunzo

Well, it'd be Lorex, Traficon, most of Raymarine and $40-ish million worth of test and measurement sales that's reflected from the Extech acquisition from 2007. Pretty much everything else has a thermal imager on it or a CBRNE piece of equipment on it.

Earl R. Lewis

And all these acquisitions are really meant to increase thermal sales. So they'll start out slow. But hopefully, the percentage increases.

Operator

Our next question is from Peter Skibitski of Drexel Hamilton.

Peter J. Skibitski - Drexel Hamilton, LLC, Research Division

I guess, Earl, your opening remarks, I wasn't sure if I heard you correct, but it sounds like you're alluding to selective pricing power in different areas. Is that correct?

Earl R. Lewis

Yes. We took a good hard look at a lot of our products in the second quarter or early third quarter and did find some areas where we thought we could have some price increases that we started to see a little of that in Q4. And we think we'll see a little more of that next year, it'll come through.

Peter J. Skibitski - Drexel Hamilton, LLC, Research Division

Okay. You don't necessarily care to mention those areas?

Earl R. Lewis

No, I probably don't.

Peter J. Skibitski - Drexel Hamilton, LLC, Research Division

Okay, okay. And then guys, other contractors certainly are seeing in front of the potential DoD sequestration, some order softness. As you guys here, into February, are you seeing that all thus far or nothing really incrementally negative for you in terms of DoD orders?

Earl R. Lewis

Definitely, we haven't seen a lot of DoD orders so far this year.

Operator

Our next question is from Tim Quillin of Stephens Inc.

Timothy J. Quillin - Stephens Inc., Research Division

Andy, could you talk a little bit about the outlook for automotive night vision just over the next few years in terms of the number of OEMs and maybe the chances of getting designed into more mass-market automobiles?

Andrew C. Teich

Sure. So Tim, a couple of things that are going on there. First of all, 2012 was a tough year. In fact, Q4 of '12, the auto business was down by about $5 million for us. So it was -- given that the overall cores business was up, we had to make that up elsewhere. 2013, we have a new OEM coming online, that's Daimler in the S Class, and that will start production in the second half of the year. So we won't see any meaningful effect from that in the first half. There'll be some shipments in Q2 that will start to ramp production there. That's the new Night Vision 3 product. It's unlikely that there will be any other OEMs that will come online in 2013. We may pick up some other Asian lines in 2014. And when I say we, I mean Autoliv. But that's yet to be determined. So they're working a number of different prospects there. I think the thing that's interesting here is that the Night Vision 3 brings 2 fairly useful features into the product line. First is animal detection, which we have not had in the past. And the second is a spotlight function, that automatically directs a LED spotlight from the vehicle to the object that's detected on the side or in the road, which both alerts the driver visually to that and alerts whatever the object is. If it's a person or an animal, they've got a spotlight shined at them so they know that there's a vehicle approaching in a more meaningful way. And I think that from a user perspective, that's going to add to the value proposition of the product. We also hope that prices come down in that market. We've continually reduced our cost, and we hope that, that gets reflected at the vehicle level.

Peter J. Skibitski - Drexel Hamilton, LLC, Research Division

That sounds very interesting. And then just generally, can you all talk about other acquisitions you might consider? And you've had these series of acquisitions that help open up new vertical markets for you or further penetrate vertical markets. Can you talk about anything else that are opportunities for you to get deeper into through acquisitions?

Earl R. Lewis

No. We did just acquire 2 businesses that we now have to integrate and fix and do a better job with. We do believe that Raymarine, by the way, is now a lot more stable and producing good results. And ICx looks like it's coming around now, so it's moving definitely in the right direction. We've tackled 2 more. And as of right now, I don't see us making an acquisition in the first or second quarter of this year, Tim. Maybe third quarter, fourth quarter, we might. But right now, I wouldn't suggest anything for us in the immediate future.

Operator

Our next question is from Paul Coster of JPMorgan.

Paul Coster - JP Morgan Chase & Co, Research Division

Tony, I wonder if you could just tell us whether the Lorex and Traficon businesses contribute meaningfully to either backlog or visibility?

Anthony L. Trunzo

No, there was -- they brought $5-ish million of backlog with them. The Lorex business carries very little backlog. Traficon has a little bit. But as I said, it's a relatively small revenue generator. I'm sorry, what was the second part of the question...

Earl R. Lewis

Well, the visibility. Yes, we see it as roughly $100 million, as we've said, in additional revenue in 2013.

Paul Coster - JP Morgan Chase & Co, Research Division

Andy, these businesses, the newly acquired ones, are going into some fragmented markets. I know in traffic violations and road safety camera operations, it's a fairly -- there's a cluster of companies that dominate in managed services and similarly in home security solutions. What's the go-to-market strategy for these businesses? And what is the synergy that FLIR brings to the table in terms of channel?

Andrew C. Teich

Well, first of all, let's talk about traffic. In the traffic case, we don't have -- there's no managed services type of business there that we are engaged in, nor are we involved in law enforcement violation detection and enforcement at all. This is all relative to automated incident detection and what they call stop bar monitoring, which are the cameras that go at intersections. There, you're selling to an integrator and an integrator is selling to a municipality. Traficon has -- is a very well-known brand in that space and is a leader in the space and has a, quite a good distribution network. I would say the only area where Traficon was probably a little bit weak is in the U.S. and frankly, that's where we're strong, because we've been selling traffic cameras there, thermal traffic cameras there now for a couple of years and have developed a pretty strong distribution channel there. So the synergies between the 2 organizations there, I think, is quite strong. And Traficon will roll into our -- be part of the CVS organization, which rolls up into TVM. Moving over to Lorex, there are 2 pieces to Lorex. There's the consumer piece, which is online, big-box, wholesale plus, Costco, BJs, Home Depot, things like that. That's an area where we're not present, for the most part, for FLIR, but we want to be present long term. So there's -- we're quite interested in having that knowledge base come into the company. The second is online. It's the fastest-growing piece of Lorex's business. They've done an outstanding job there. They have a direct link between their online system and SAP, which is the ERP that we're running off of. So we'll carry that back into FLIR. And then the other piece of Lorex is Digimerge, which is a traditional self-integrator business. And interestingly there, there are kind of 4 large security distributors in the U.S. And today, FLIR is aligned with 2 and Digimerge is aligned with 2, and they're not the same ones. So it now gives us essentially an avenue to use all 4 of those major camera distributors across the FLIR and Digimerge alliance. So I really like the synergy there. Lorex and Digimerge do nothing internationally at all. They're completely North American-based businesses. So as we've done with Extech, we'll carry them over internationally using our existing international distribution network.

Operator

Our next question comes from Brian Ruttenbur of CRT Capital.

Brian W. Ruttenbur - CRT Capital Group LLC, Research Division

Just a quick question about the weighting of revenue and earnings. For the year, can you talk about, traditionally, you've been back-half weighted in terms of your earnings. Can you talk about how you look at first couple of quarters of 2013?

Anthony L. Trunzo

Well, if you look at our outlook for this year compared to last year and look at the performance last year, the comp that is probably going to be the best, where you're going to see the biggest growth, is going to be Q2. Because Q2 last year was clearly our weakest quarter. But there's no -- other than the typical seasonality in terms of earnings per share, there's no back-end weight to our outlook. In other words, we're not, we haven't said today that the first half is going to be weaker than the second half relative to its, sort of the historical seasonality of the business, and I think that's right. I think when you look at percentage growth quarter-over-quarter, Q2 is going to be the best one that you'll see. And the other ones will be more modest.

Brian W. Ruttenbur - CRT Capital Group LLC, Research Division

Okay. Can you say the same thing about revenue then too?

Anthony L. Trunzo

Yes. I guess you can.

Earl R. Lewis

Yes, they'll track. They both track, sure.

Operator

The next question is from Jeremy Devaney of BB&T Capital.

Jeremy W. Devaney - BB&T Capital Markets, Research Division

We were just talking about Lorex a little bit, and you continue driving towards high-volume, low-price tag sensors. And I was just curious, this appears to be a bit of a commoditization of your technology. I'm wondering if you could discuss what kind of barriers to entry you have in place to protect your market position, how you maintain or expand margin in those end markets where price or cost is key to customer adoption?

Earl R. Lewis

Boy, you got an hour? Golly. Yes, Andy, you're going to have to talk about that, but each market is different. Just in general, our idea has always been, still is today, that very high volumes of infrared detectors and cameras across multiple channels will be helpful to us in protecting our overall market share and growth in the future. So as we add on distribution, essentially what we've done with these 2 acquisitions, we will also add on significant amounts of revenue of detectors and cameras that are made with infrared equipment, which will, as I think we've pointed out before, continue what we believe is this virtuous cycle to go through every market. Andy, you want to give it a try?

Andrew C. Teich

Well, I think one thing is just to talk about at the top level, I don't feel like thermal imaging technology is commoditized at all at this point. This is very early days in this technology. Microbarometers are probably easier to build than they are to get high-quality imagery from. So even nat-set [ph] barometers are fairly difficult to build. It's a complex MIM structure. But beyond that, the process of calibrating a microbarometer, getting a very high-quality image out of it, in an expeditious way in the manufacturing process is difficult. And it's covered both by intellectual property and trade secrets that FLIR holds. To that end, on the intellectual property side, we've been very aggressive in developing intellectual property over the last 12 months in particular. We have filed a number of patents that we filed in the last 18 months that's been significantly higher than what we had done historically to help protect our technology. And the other thing that's important here is volume. This is a semiconductor process. And the more you build, the less expensive they are. And you want to be the leader on the volume side. And today, we have almost a 3x advantage over anybody else in the market and we intend to maintain that gap.

Earl R. Lewis

That's been our strategy. It continues to be our strategy. And I think the commoditization issue, yes, we understand how Lorex cameras today are -- can be viewed to a certain extent as more commodity. But when they become infrared cameras, they join a new group, if you will. It certainly isn't commoditized. And there, you differentiate and get better prices, et cetera.

Operator

Our final question comes from Peter Skibitski of Drexel Hamilton.

Peter J. Skibitski - Drexel Hamilton, LLC, Research Division

On your Surveillance outlook for 2013, are you basically thinking U.S. down, Europe down and maybe Middle East and Asia offset. Is that kind of the ballpark there?

Anthony L. Trunzo

For the whole business?

Peter J. Skibitski - Drexel Hamilton, LLC, Research Division

For the Surveillance business, correct.

Anthony L. Trunzo

Just for Surveillance. We haven't typically gone there.

Earl R. Lewis

For our total business, we're still thinking Europe will be on the lighter side, and U.S. will be a little bit better and the Far East would be even better. I think that's in total across our company. We do have detailed plans that would go into Surveillance and where we think it will come from. I don't have that handy though. But overall, clearly, we've invested a lot of money this year, 2012, in the Far East, less in Europe and a little more in the U.S. in terms of developing additional channels, additional sales folks. And we haven't really pointed out, I think our R&D was almost 10% of revenue in Q4. It was fairly high, and that's kind of given us some momentum as well on new products into next year, this year.

Peter J. Skibitski - Drexel Hamilton, LLC, Research Division

Can I sneak in one last one? On thermography, the sales declined in the fourth quarter there. Is that the continuing things, like predictive maintenance and advanced R&D systems?

Earl R. Lewis

Those are all very high-end systems that slowed up. But I'd be remiss in not pointing out that our order entry actually was up significantly compared to the year-ago Q4. We took down backlog fairly aggressively a year ago. This year we didn't, so we actually saw some very good signs of increasing orders in our Thermography business.

Andrew C. Teich

We had an all-time high in terms of orders also.

Peter J. Skibitski - Drexel Hamilton, LLC, Research Division

Is the housing market recovery helping that in terms of the home inspection items?

Earl R. Lewis

It will. Whether we can actually pinpoint that or not, I'm not sure. But clearly, we do think that our orders increase when homes -- when the housing market gets better.

Operator

That is all the time we have for questions. I'd like to turn the floor back over to management for any additional or closing remarks.

Earl R. Lewis

Well, just thank you all for listening, and we actually are looking forward to this year. It looks like we feel like we've done the right things to prepare for it. We feel like we may have a little wind behind our back compared to last year, and we're looking forward to sharing with you some good results in 2013. Thanks for listening.

Operator

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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